Saturday, October 17, 2009

Inequality and the economic crisis

Financial crises are considered being inherent to capitalism. As J. Stiglitz* put it, the roaring 90s of boom contained the seeds of self-destruction. Deregulation, excessive risks, creative accounting and tax cuts in favour of the wealthy led to the current disaster. But there is another factor which is often neglected in the analysis of the current crisis. Rising income inequality since the beginning of the 90s not only in the US but in almost all developed countries has been an important driving force in the global financial crisis.

The wealthiest - the top ten per cent - receiving a growing share of national income, directed huge financial resources into asset markets causing asset price bubbles. The middle class - say 60%- experienced a drop in real wages- especially in the anglo-saxon world and started borrowing massively as house prices rose, which helped postpone the problem of underconsumption or excess in production capacity. But eventually the gap between rising debts and less disposable income increased dramatically.

The same mechanism operated in the US during the 30s in the build up to the Great Depression. J.K. Galbraith* writes that the GNP (total production of the economy) was nearly less than a third in 1929. The overwhelming majority of tax payers had lower disposable income, while the top 1 per cent increased their revenues and corporate profits significantly. Speculation on a large scale went on during subsequent years : rising profits went into real estate and stock markets feeding the asset bubble. In the aftermath of the great crash, the majority of workers is confronted with less income and greater uncertainty about jobs.

What should be done to tackle income inequality? Huge fiscal stimulus programs were launched in the US, Japan, China and most European countries to sustain global demand. But the key to reduce inequality is to combine measures to sustain employment with income redistribution through the State. But other policy areas need careful attention. They include inter alia reforms of corporate governance as well as capping to bonuses for traders in order to put limits on maximising shareholder returns at the expense of wages.

More fundamentally, a new balance between capital and labour needs to be restored. Governments should act as a matter of urgency to tackle widening inequality as rightly pointed out by Matthew Slaughter (FT October 7). The steps taken by the Obama administration, particular on healthcare and taxation go in that direction but what about the European countries where only temporary measures are taken to prevent social explosion with unprecedent rise in unemployment?

¨* J.E.Stiglitz, The Roaring Nineties, Norton , New York, 2003
** J.K.Galbraith, The Great Crash 1929, published for the first time in US in 1954. This classic book is an illuminating essay on the causes of the Great Depression.

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